The second quarter was marked by widespread concerns about sovereign debt, the oil rig explosion in the Gulf of Mexico, and financial regulation that drove global equity prices down significantly. Stock volatility skyrocketed to levels not seen since March 2009, as investors were faced with markets that whipsawed. Early in the quarter, the "flash crash" in the U.S. stock market and the Greek sovereign debt crisis caused asset prices to tumble. This was followed by significant government interventions in the European Union designed to address their debt crisis. The size of these interventions resulted in an instant rise in global stock, bond, and currency markets. This rally subsequently collapsed in the closing weeks of the quarter, as investors' fear of a renewed global economic downturn prevailed. 

The S&P Developed Ex-U.S. BMI posted a -12.7% decline, with all countries, save South Korea, posting negative returns for the quarter, the biggest negative drop since October 2008. Greece led the developed markets decline with a -32% drop in local terms. Belgium, Germany, and Denmark fared much better on a relative basis, declining less than -5%. 

In the U.S., all of the Russell indices posted results in the range of -9% to -12% for the quarter. Smaller cap issues outperformed larger cap stocks, and growth outpaced value. Energy, consumer discretionary, and health care stocks were significant underperformers, illustrating investors' wish to reduce their exposure to economically sensitive parts of the economy.

The leading macro economic indicators certainly give credence to the markets' fears concerning a dramatic global slowdown. Whether it is the price of oil, industrial commodities, or the Baltic Dry Index (a measure of global shipping prices), these measures of expected economic activity have all fallen, been volatile, and are off double-digits from their highs earlier this year.

Interestingly, bottom-up analysis tells a different story than the top-down macro economic forecasts. Analysts are quickly raising earnings estimates for companies, and, in the past when we have seen this dichotomy, it has meant that there are solid opportunities to be had at the individual company level. During the turmoil of the second quarter, the number of upward changes in estimated quarterly earnings by brokerage analysts outpaced downward changes. If current economic wisdom is correct, we would expect to see a large percentage of downward revisions to what analysts expect companies to earn over the coming quarters. However, we see the exact opposite -- in each future quarter analysts have been raising their expectations. 

The contrasting opinions of bottom-up analysis and the macro economic forecasts are even starker when we consider the magnitude of these earnings revisions. Over the last three months, analysts have sharply raised their forward-looking earnings estimates for this year, even as they factor in the impact of the sovereign debt crisis. On June 30, earnings per share for companies in the S&P Developed Ex-U.S. BMI are now expected to jump almost 10% in 2010, compared with a projected gain of less than 2% percent on March 31, 2010. Meanwhile, the stocks of these international companies were down -12.7% for the quarter and the stocks in our portfolio are expected to grow earnings by 16% this year! 

In the U.S., analysts are raising earnings estimates at the fastest rate since 2004! Additionally, the magnitude of the positive revision for this year's earnings-per-share forecasts has been about 10% over the last three months -- significantly greater than the magnitude for the lowered forecasts. The bottom line is that earnings per share for U.S. corporations are now expected to jump 34% in 2010 compared with a forecasted 27% increase on March 29, 2010 according to research by Bloomberg. However, U.S. indices have declined between -15 to -18% from their highs during this positive earnings revision period.

At this point, we believe the market has sold off many companies well beyond what the likely economic scenario will be. Though many leading economic indicators point to a decline in global growth, bottom-up analysts that meet with management, pore over balance sheets, scrutinize supply chains, and examine customer orders see a different story, and have been revising their earnings estimates upwards. This concurs with our own analysis of the individual companies in our portfolio. 

The increased frequency of government interventions in response to this uncertainty has caused continued equity market dislocation and moved investors away from the fundamentally-focused market we experienced in the first quarter of this year. While this current environment is not conducive to bottom-up investing, our perspective is that the economic foundation is now more solid than it was in 2008, and we do not believe that last quarter's sell-off is a precursor to another impending global market or economic crash. We expect that investors will soon realize that the management teams of the companies in our portfolio are doing a superb job of generating growth and they will be rewarded by the capital markets in the months and quarters ahead.